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Know the difference between investments

Chapter 5: Common investments

Transcript

00:20:26 TONYA: Alright, so moving on: common investments. We’ve spoken about starting now, starting early, identifying your time capacity, your time horizon, now what are we going to invest in? What are the common investments that people should be looking into?

00:20:40 EARL: Well, you know, there are different asset classes. You got cash and you got cash equivalents. These would be like your savings accounts and bank accounts and money markets, different types of things like that. You got bonds. You wanna think of bonds like you think of a loan. And you got equities or better known as stocks or stocks better known as equities. And so all of these are going to be different asset classes that you can invest in.

00:21:11 TONYA: So we have stocks and we have bonds. Can you just explain simply what those are?

00:21:16 DAN: Absolutely. So think of a bond like a loan. Right? You take in loans like I get my mortgage and I maybe get my car loan. It’s just the opposite. You’re loaning out money to a company, or a government or maybe a city, and they’re paying you back, generally, a fixed amount, a fixed interest rate. So these are often called “fixed income” because of that.

00:21:39 TONYA: Okay.

00:21:40 DAN: And then at the end of the bond, they’ll return the money you originally lent them with that final interest payment. Stocks are ownership in a company. So that’s why they’re also called “equity” just like ownership in your house is called your “equity”, ownership in a company is called “equity”. So you own a very, very small percent of a company. You can kinda make money two ways here. One, the company can be worth more.

And if so, your stock may go up in value. Or they can pay you what’s called a “dividend.” So, small company like a pizza shop, they are trying to make money and pay their drivers and order new ingredients, and market. In the end, if they have money left over, the owner uses that to pay their bills. Big companies are no different. A big company makes 30 billion dollars, and they take 20 billion of it to market and come up with a recipe and build a new plant, and there’s some money left over.

At the end they will give it to their owners, which are stockholders. So you’ll get a dividend. A couple of cents, maybe a dollar, who knows? But they’ll pay you some back.

00:22:41 TONYA: I think that’s a great example.

00:22:42 EARL: Yes, and of course stock are, just like Dan said, they’re on the other end of that, and again we’re back to time horizon again because what you’re trying to do depends on the asset class you might invest in. But if you are gonna be in bonds, you gotta—you know they come in the forms of government bonds, they come in the form of municipals, which is meaning that some municipality is doing some project, like a city or a county or something like schools.

Or you may have a corporate bond, which corporations use to buy different things, to build buildings, to do different things with that money, and so it’s important to understand that these earn interest on their money.

00:23:34 TONYA: Got you. So, Dan, I have a question for you.

00:23:35 DAN: Yeah, please.

00:23:36 TONYA: If someone walks into your office, they say, “You know, my coworker was talking to me about stocks and bonds. Which one should I look into?

00:23:42 DAN: I think Earl’s totally right. What’s you risk tolerance? What’s your time horizon? What do you need? And to be honest with you, the thing that I just love that he mentioned is there’s also different risk profiles within these.

00:23:53 TONYA: Within, yeah.

00:23:54 DAN: Right? So, I think this is a great example and a great place to talk about why risk and return move together. Let’s say I have a very small company, right? And I want to borrow money. I offer you a bond. The chance that I go out of business is pretty high. So, if I offer you 2%, and the government’s offering you 2% and you’re much more confident the government’s gonna pay you back, you’re not gonna give me any money. So what if I say I’ll give you 6%?

Well, then what if you find out a much bigger company is giving you 6%? Again, you’re gonna be like, “I’m not gonna give you that money. I’m much more comfortable at big companies that pay me back.”

00:24:27 TONYA: Yeah.

00:24:28 DAN: Then what if I say, “Okay, I’ll give you 8%”? Then suddenly-

00:24:32 TONYA: It gets attractive.

00:24:33 DAN: Well, maybe, maybe not. That’s where your risk profile, your time horizon starts to make you think about, “Am I okay with that slow, and steady and consistent or am I willing to take this chance for more return?”

00:24:46 EARL: Yeah. And so basically what Dan is saying is the more risky his company is in terms of issuing that bond, to induce me and to entice me to take it he’s got to offer me a bigger return. Otherwise I’m not gonna take the risk.

00:25:00 TONYA: So, high-level overview: a stock is…

00:25:05 DAN: The riskiest.

]00:25:06 TONYA: Yes. And then the bonds are…

00:25:08 EARL: The bonds are in the middle, and then your cash equivalents, your savings accounts, your cash, is gonna be the safest.

00:25:14 TONYA: There are a variety of investment vehicles available to you, and it’s important to understand which one works best for you and your future goals. Let’s have a look at what we’ve learned.

00:25:22

(Music / Chapter 6 Ends with Key Takeaways slide)

Cash equivalents, bonds and stocks are some common investments you're likely to see. Your personal time horizon might help you decide which investment to use.

What are cash equivalents?

Cash equivalents are short term government bonds with maturities less than 90 days.

Here are some examples of cash equivalents:

Commercial paper

Marketable securities

Money market funds

Short-term government bonds

What are bonds?

Bonds are loans you make to another entity. Bonds are considered a medium risk and reward.

There are several options when it comes to bonds, here are a few to consider:

Corporate – Corporate bonds are issued by public and private corporations.

High-yield – These bonds carry a higher risk with the possibility of a higher reward.

Municipal – Securities issued by cities, states, countries, and other government entities.

What are stocks?

If you’re planning to invest over a longer period of time, stocks are an option to consider. Stocks offer partial ownership in a public company. There are two main kinds of stocks: common and preferred.

Common – This type of stock allows owners to vote during shareholder meetings and receive dividend payouts.

Preferred – Stockholders typically don’t have the voting rights but they do receive dividend payouts before common stockholders do. They also have priority over common stockholders should the company go bankrupt and liquidate its assets.

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